Against the Grain

WWAV

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I don’t think I could ever work for a macro-strategy investment company. When I hear about investment ideas centered around relative currency strength, anticipated interest rate movement, commodity prices, and yes, world-wide oil supply/ demand, my head starts to spin and I have trouble seeing the forest from the trees. I’m much more comfortable opining on whether I think people would prefer to eat a Big Mac or Whopper (and who has a better balance sheet) than what’s going to happen to worldwide beef prices because of the political situation in Brazil. That doesn’t mean that I don’t at least try to understand macro issues and their implications; rather, I try to know my limitations and keep the faith that my investment strategy will eventually weather various macro storms I don’t fully understand if I can find good value in great long-term businesses.

With oil prices down almost 50% in the last six months alone, every investment expert is weighing in with their view on how this will affect the market. It’s a complicated issue- obviously lower gas prices for consumers is great in that people can spend their money on other things and great for countries that rely on importing gas, but it’s not so great if energy-related loans start defaulting and impacting banks or the U.S. loses a big chunk of the previous job gains over the past 5 years that were energy related.

My conclusion on this whole issue is that I simply don’t know what’s going to happen with oil prices and how it will affect the overall market, so I’d like to explore opportunities within the market that are less impacted by oil prices (or ideally not at all impacted).

Below are some of my thoughts on stocks/ themes that meet two criteria: (i) I think they are good stand-alone investments ideas for 2015 and (ii) I don’t think that oil price movement (good or bad) will have a huge impact on their success or failure.

Battered down brand names/ re-positioning stories:

Weight Watchers (WTW): After a fantastic 50% run-up in the second half of 2014 due to new leadership, improved technology, earnings beats, and revised upward earnings estimates, the stock has mysteriously lost 30% in value over the past 3 weeks alone with no material news other than the fact that some people didn’t “like their new magazine layout”. I’m still a believer in what the new management team is doing and am looking forward to another nice run.

Hertz (HTZ): Despite being transportation related, I don’t think oil prices will swing the dial much for Hertz; it all comes down to whether the new leadership can execute a successful turnaround and restore investor confidence in their operations, strategy, and reporting. If they can, this stock has tremendous upside. If they can’t, you are at least left with an iconic brand name and infrastructure that is near impossible to replicate.

Lower-end consumer product and food companies:

YUM Brands (YUM): People might eat a little more junk food with lower oil prices, but a larger driver of growth for companies like YUM (parent company of KFC, Taco Bell, and Pizza Hut) is their ability to grow into new markets and take share from competitors. moMANon wrote a great piece on YUM and why he feels that the Pizza Hut re-branding has the potential to take some meaningful market share from its competitors and move the earnings dial for YUM.

Health/ organic oriented food companies:

Whitewave Foods (WWAV): The other day at the grocery store I was shocked to have paid more for a gallon of organic milk for my kids than I typically pay for a gallon of dairy alternatives like soy or almond milk. Oil prices won’t dictate whether people drink milk or diary alternatives, and Whitewave has been on fire with 10 straight quarters of beating earnings expectations, year-over-year revenue growth exceeding 40% and encouraging new partnerships in china to expand their reach. ATG is going long again on lactose intolerance.

High Tech:

My personal favorite play here is probably Corning (GLW), the leading manufacturer of durable glass for tv’s, phones, and tablets. I don’t have a great “ATG” theory of why they will outperform other than I just love the company, their market dominance, and ability to continue innovating over the past 100+ years. Google (GOOGL) also feels cheap to me right now, but if oil prices cause an overall market shock downwards for some reason, I could see the mega-cap, high trading volume companies getting crushed simply from investor fund withdrawals.

Non-equity income and dividend plays (non-energy related of course!):

There’s nothing wrong with parking some money in non-equity dividend plays if you are nervous about energy prices rocking the market. Within the ATG portfolio we have increased our allocation to iShares U.S. Preferred Stock ETF (PFF), a large basket of predominantly bank-related preferred shares that are currently yielding 6.33%. If low oil prices were to trigger bank defaults, PFF would certainly be impacted, but not nearly as much as the underlying equities would be impacted.

With over 3,000 publicly traded companies in the U.S. alone and who knows how many mutual funds and ETF’s, investors have plenty of opportunities to pick their spots and limit exposure to certain factors of their choosing. I’m not staying away from the market, but I am staring away from big oil price bets in my personal portfolio for now.

Despite the terrible title, “You Can be a Stock Market Genius” by Joel Greenblatt is on the short list of best investment books out there- probably my favorite. Joel is the founder of Gotham Capital and one of the most influential value and special situation investors around. I often use his value stock screening website for ideas (www.magicformulainvesting.com) and have been heavily influenced by his investment philosophy and approach to finding opportunities.

In the “Stock Market Genius” book, Joel spends a great deal of time discussing the general investment attraction of spinoff companies, which are companies that break off from larger public companies and operate as a stand-alone public company. A couple of irritating consequences of spin-offs create a source of opportunity in Joel’s view:

When people own a company that effects a spinoff, they tend to sell their spinoff company shares because they don’t want to take the time to evaluate a new stock and it’s usually a small position relative to their holdings in the former parent company.

Large money managers usually don’t focus on spinoffs simply because they are smaller in size and may fall outside of their index parameters.

Logically a parent company wouldn’t spin off and sell a piece of their business unless it was in their best interests- most investors are very hesitant to buy something that the insiders (who have way more information and insight into the business) are selling.

Joel boils it down to the idea that unlike an IPO, spinoffs are designed to give shares in a new company to people who probably don’t even want them, creating an initial negative price pressure on spinoffs that has nothing to do the quality of the company itself.

Now for the generalized bull case on Spinoffs:

Spinoffs often give executives a more direct opportunity to have their personal compensation relate to the success of the company itself. (An example might be if the dude who runs Frito Lay underneath Pepsi was given huge stock options in Frito as potential compensation as part of a spinoff).

Unburdened by a larger corporate environment, spinoffs often can be more nimble in decision making, capital allocation, and growth initiatives.

Parent companies usually retain a decent minority chunk of the spinoff company and have a vested interest in seeing the new company succeed. (Think of it like having a big brother that looks out for you as you start high school).

Every situation is unique and must be evaluated in earnest, but I agree with Joel that there are structural elements of spinoffs that have the potential to create outsized returns. His book cites research indicating that from 1963-1988, stocks of spinoff companies outperformed their industry peers and the S&P500 by about 10% per year in their first three years of independence. In looking how they might have performed as a group relative to the broader index more recently, I pulled up a chart of the Guggenheim Spin-Off ETF (CSD): Sure enough, the Spin-Off ETF handily beat the S&P 500 return over the past 7 years (about 80% gain vs. 45% for the S&P 500), although it should be noted that the superior performance of the ETF didn’t really start kicking in until 2013:

One of ATG’s holdings, White Wave Foods Company (WWAV), is a recent spinoff success story. Since parking from Dean Foods back in May of 2013, they have more than doubled their market cap through strong growth and investor appetite to pay a premium for companies that specialize in the organic food arena.

What’s the POINT of all of this?? A stock pick, of course! Stay tuned for Part II where we analyze an interesting spinoff that’s a strong contender for the portfolio.

In the past 10 days the S&P 500 has dropped over 3% over Russia/ Ukraine tension, Argentinian bond defaults, fighting in the Gaza strip, improving GDP numbers that could trigger an unwinding of quantitative easing, and who knows what else. Anyone who claims to fully understand the complexities and future implications of each of these events should be thrown in a padded room (or given a spot on CNBC Squawk Box).

This is the bad news- aside from diversifying across asset classes or dollar cost averaging, there is very little an investor can do to anticipate and guard against these unforeseen events.

Now for the good news- Despite all of these events and the recent drop, the S&P 500 is still up 5.5% on the year and plenty of stocks continue their upward march as the economy improves and earnings improve. This little 3% “hiccup” from macro and geo-political uncertainty may provide some discount shopping opportunities.

Here’s my take on discount shopping in times like this:

This is a “sale” opportunity and not a “clearance” rack. Make sure you buy quality companies that you believe in over the long haul just in case that sale turns into a clearance after you buy and a patient holding period is necessary.

Start with looking at the stocks you already own and know well: buy more of the stocks you still really like that have taken a hit, but make sure you re-visit their financial position and prospects for growth.

Look for companies that are actually on sale at the moment and have dropped materially from their highs (or have below-market P/E ratios). For example, I’ve been waiting for an opportunistic time to open a position in Disney (DIS) because I love the company, have a 3 yr old daughter obsessed with Tinkerbell, and I believe they have incredible staying power, but their stock price has not been affected at all by the geo-political and macro noise over the past month. I’ll have to wait on Disney until the next sale or clearance opportunity.

Based on the criteria above, ATG has taken an entry position in John Deere (DE), added to its position in Ensco (ESV), and will likely be adding to its position in Google (GOOGL) and Whitewave Foods (WWAV). We are also looking harder at airline and transportation stocks for sale opportunities.

It’s no coincidence that all the companies listed above are long-standing companies with huge competitive advantages in what I believe to be high growth industries. Can you imagine a (near) future with increased capital spending on agriculture, energy consumption, continued dependence on online marketing/ e-commerce, more demand for non-dairy organic substitutes and increased travel for commerce and pleasure?

The ATG Investment team has finally gotten off its ass and opened its joint investment fund. On a monthly basis we will update the positions and share true performance of the fund in the “Current Portfolio” tab of this blog. On April 17 we established initial positions in 7 different securities and allocated a total of 25% of the available capital to these stocks. Over the next several months we intend to slowly build up the investment fund to approx. 80% invested in the market with 20% in cash as a buffer. The investment allocations of each security are reflective of our perception of current price- for example, WWAV has a smaller allocation than ESV currently due to the recent run up in its price before we established an initial position. If pricing dynamics change 30-60 days from now, we will adjust the allocation to try and take advantage of pricing and build a more favorable basis in any given security. We plan to limit the total number of different investments at any given time to around 10. Our logic is that its enough to provide meaningful diversification but not too many to lose focus or dilute the ATG team’s best overall ideas.

Without further adieu, below is the initial ATG portfolio:

OZM (Och-Ziff), ESV (Ensco), CLNY (Colony Financial), WWAV (White Wave Foods), and PFF (iShares Preferred Shares ETF) have all been discussed in prior ATG posts. GOOGL (Google Class A) was a bit of an impulse, last minute add to the portfolio in light of their recent modest price drop. Any portfolio should have some high quality tech exposure, and GOOGL is probably the most reasonably priced of the high growth names at 17x 2015 forward earnings.

VNM (Market Vectors Vietnam) is an ETF that tracks the Vietnamese stock market. Both Maverick and moMANon have had the opportunity to visit the country before and are in agreement that this is our favorite emerging markets bet right now (and favorite southeast Asian cuisine option). I’m sure an ATG post is forthcoming laying out our argument for the opportunity.

Overall we’re trying to build a portfolio that balances attractive yield (PFF, ESV, OZM, CLNY) with higher growth/ beta securities (VNM, WWAV, GOOGL) in hopes of beating the S&P 500 and earning positive returns even if the market ends down for the year. We are also trying to stay true to the original ATG principal that any security we pick is one that we’d be comfortable holding for several years to ride out any wild, unpredictable market moves.

As always, we welcome any feedback or thoughts as we build up the portfolio and share the performance publicly. To avoid any misunderstanding from potential readers, I want to make it clear that the ATG Fund represents only a portion of the ATG team’s respective personal investment strategies. Any responsible personal investment strategy should have diversification among various investment classes (stocks bonds, real estate, etc) and have a meaningful percentage of diversified index/ mutual fund holdings in addition to any individual securities. For any readers who’d like to talk more about an overall investment strategy, write us a message and we’ll be happy to share our thoughts.